The euro may well prove the key to se-curing a truly free market in investment products over the longer term - succeeding for investment funds where the UCITS directive has struggled.
Monetary union brings many threats and opportunities; financial institutions are already responding to perceived threats, as evidenced by frenetic cross-border merger and acquisition activity. The winners will be those that can maintain and expand their market share, while responding to both a more competitive market and a more de-manding consumer. One of the inevit-able effects of EMU will be a reduction, through consolidation, of the number of mutual funds. Based on funds where the base currency is expected to be in the first wave of EMU, our analyisis shows that of the 466 Luxembourg money market funds with total net as-sets of $101.2bn at 30 September 1997, at least 168 are likely to be merg-ed with others. Our estimate is that these 168 funds would reduce to 47. For bond funds, of which there were 1,283 worth $155.8bn at 30 September, at least 315 funds can be expected to undergo some form of transformation, and will reduce to about 100.
As other currencies join, so the fund mergers will continue. Funds wh ose base currencies are not included in the first wave may become less attractive. Conversion and merger into a euro-denominated fund is the obvious solution. This could affect not only funds whose currencies are potential EMU participants at a later stage, but also, if the euro is as intended a hard currency, Swiss franc-denominated funds for example.
As average fund sizes for both money market and bond funds increase dramatically, and a similar effect can be expected in equity and balanced funds, the economics of fund management will be transformed. Some marginal products can be dispensed with. Significant savings will be available in prospectus, listing and registration costs. Fund accounting costs will be reduced and spread across more significant asset bases. This translates into an opportunity to benefit from significant economies of scale, giving managers more room for manoeuvre as competition hots up and margins come under pressure.
The mutual fund industry will not stand still. The industry is expanding and there is mounting evidence that cross-border business is growing. As the common currency becomes established, so cross-border ambitions of fund promoters will be more easily re-alised. What will be interesting is how the shape of business changes. Ab-sence of currency risk will be beneficial, not only in terms of costs but in simplifying the investment process. An investor's view of what constitutes a domestic equity, bond or money market fund will change radically. That to-gether with an expected shift in EMU-compliant countries away from government debt, and a continuation of a low inflation/low interest rate environment should change the balance be-tween asset classes significantly over the longer term in favour principally of equities, but also of corporate debt.
As the wider EMU zone becomes 'domestic' the focus for diversification will shift firmly outside European boundaries. Bu the introduction of the Euro has associated costs as well as benefits. Some, possibly many, mutual fund groups will disappear. However, opportunities will emerge for new groups to develop niche business against the backdrop of the growing power of the supergroups.
Sheenah Gordon Harte is with Lipper Analytical in London.